Weekly Chart Review
Continue to watch the Technology sector, rates, and high yield...
Sector Review
Let’s start as we did last week by comparing our two sets of charts.
The first is our “absolute” view where we look at the return of the S&P 500 and the individual sectors over the previous year and where they rank in terms of standard deviations.
The second is our “relative” view where we look at the return of the individual sectors of the S&P 500 and where they rank “relative” to the S&P 500 over the previous year.
Similar to last week, the main takeaway is that the Technology sector continues to lead the pack by a lot. Technology has now crossed the 2.0 standard deviation level in both absolute and relative terms.
In terms of standard deviations, Technology has ranked as follows:
Week ending 05/12/23 -
Absolute = 1.77 standard deviations
Relative = 1.95 standard deviations
Week ending 05/19/23 -
Absolute = 2.33 standard deviations
Relative = 2.54 standard deviations
Typically, when any asset gets north of 2.0 standard deviations, this is where you would begin to look for either a corrective pullback or a consolidation move sideways.
As we will see below, it doesn’t mean that a corrective pullback or a consolidating move sideways will happen immediately, but your antenna should be up the longer Technology remains above 2.0 standard deviations.
Support and Resistance
Last week, I provided the following chart and made the following comment regarding the blue horizontal line in the chart:
“You can pretty quickly see that the current price level of around $152 has repeatedly acted as either support or resistance. The last four times it has approached this line, the line has acted as resistance.”
“Given technology’s current ~2.0 standard deviation move, I’m inclined to think the blue line could be another period of resistance.”
Well, I was wrong. Fast forward one week and I have provided the same chart below. Note the green candle on the far right. It cut through the blue line like a hot knife through butter on its way to posting a 4.33% return for the week.
Is this the beginning of a prolonged breakout where the blue line becomes support similar to the second half of 2021? Or was this just a blow-off top on its way to move back below the blue line? Only time will tell.
Standard Deviations
Recall, in absolute terms, the one-year return for the Technology sector just reached 2.33 standard deviations.
The chart below is the same chart as above but I’ve added Bollinger Bands to denote the different standard deviation levels.
Green = 1.0 standard deviation
Blue = 2.0 standard deviations
Red = 3.0 standard deviations
When looking at the chart this way, you find that while it is certainly possible to live above the 2.0 standard deviation line (numbered blue-shaded circles), you typically don’t stay there very long. And as I noted above, this is where we are likely to see the beginning of either a corrective pullback or a consolidating move sideways.
Going back to the beginning of 2020, we have four different periods where the Technology sector traded above 2.0 standard deviations.
All four episodes had two similarities:
They remained above 2.0 standard deviations for several weeks.
When they corrected or consolidated, they always corrected and/or consolidated down to at least the 1.0 standard deviation line (and sometimes further).
Where they differed was in where they stopped. Let’s look at each episode:
Corrected down to the -2.0 standard deviation line for a peak-to-trough decline of -33.84%.
Corrected down to the 1.0 standard deviation line for a peak-to-trough decline of -14.21%.
Consolidated sideways to the 1.0 standard deviation line for a peak-to-trough decline of -5.26%.
Corrected down to the -1.0 standard deviation line for a peak-to-trough decline of -20.37%. Note: after a brief three-week rally, the Technology sector would go on to correct down to the -3.0 standard deviation line thus extending the decline.
For reference, a decline from Friday’s close to the 1.0 standard deviation line would be a decline of -8.19%.
Why does this matter?
It matters because, at a market cap weight of 26.7%, the Technology sector is by far the largest sector in the S&P 500.
The Technology sector, as measured by XLK, has returned 26.8% YTD through Friday’s close. The S&P 500, as measured by SPY, has returned 9.9% YTD.
This means that the Technology sector alone has contributed to more than 70% of the S&P 500’s return on a YTD basis.
As I’ve said before, “As goes the Technology sector, so goes the S&P 500”.
If we extrapolate this further and look at the Technology sector in isolation, we find that the three largest holdings in XLK (i.e., MSFT, AAPL, and NVDA) account for approximately 71% of the YTD return for the sector.
If we look at these three companies on an individual basis using the same chart template as above, we find that all three are above the 2.0 standard deviation line and have been for multiple weeks.
As I said above, you can live above the 2.0 standard deviation line for a period of time but you can’t remain there forever.
Microsoft
Apple
NVIDIA
Watch Rates
The Technology sector is very sensitive to interest rates. In the following chart, I am showing the Technology sector (blue) vs. the yield of the 10-year US Treasury (red) and I have added the Fed Funds rate (yellow) for reference.
What you find is that the red and blue lines are almost perfectly negatively correlated. Simply meaning that when rates increased, the Technology sector decreased and vice versa.
More recently, we have entered a new paradigm where rates have been increasing (red line) and the Technology sector (blue line) has continued to appreciate. This is counter to what has happened since the beginning of the rate hiking campaign in March of 2022. Will it continue? I don’t know but it’s worth watching.
Watch High Yield
I have found that the High Yield market can often be a tell for equities. Note that the last three weeks in a row have been “red candles” for HYG.
Further, while not complete, HYG appears to be forming a head and shoulders top. Again, not confirmed, but should it complete, from a technical standpoint, this would call for a target price of 67.88 which is -8.52% lower than Friday’s close.
For those that prefer to think in terms of spread, here is the same chart but using the BAML Option-Adjusted Spread (OAS). A similar head and shoulders pattern is in the process of forming (albeit an inverse head and shoulders because we’re talking in spread terms) which would call for a spread target of 648 vs. Friday’s close of 469.
Conclusion
Year-to-date, the US equity market has largely been flying formation off of what the Technology sector has done.
Year-to-date, the Technology sector has largely been flying formation off of what its three largest holdings have done.
These three holdings, and the Technology sector in general, have reached levels north of 2.0 standard deviations which suggests they are ripe for a corrective pullback or at best, a consolidating move sideways.
As I showed above, this does not mean that the corrective and/or consolidating move will begin this week but it will likely take place within the next several weeks.
Watch rates and high yield for your tell.
Until next time…